Evidence Investing

 
Momentum 1.4 04/20/2010
 
Again, sorry for the slow posts...hope to remedy that soon...

Let's start to wrap up our evidence-based look at the overall concept of momentum.

#7: Review of “Momentum Strategies in Commodity Futures Markets”.  In this Case Business School research paper, the authors looked at momentum (and some other things) in the context of commodities. 

Abstract: The article tests for the presence of short-term continuation and long-term reversal in commodity futures prices. While contrarian strategies do not work, the article identifies 13 profitable momentum strategies that generate 9.38% average return a year. A closer analysis of the constituents of the long-short portfolios reveals that the momentum strategies buy backwardated contracts and sell contangoed contracts. The correlation between the momentum returns and the returns of traditional asset classes is also found to be low, making the commodity-based relative-strength portfolios excellent candidates for inclusion in well-diversified portfolios.

They look at a momentum strategy and vary it both by holding period and ranking period.  This study is really very enlightening because of their look at these two factors...as you will see when we get in to implementation of momentum strategies. 

Let’s look at some of these findings.   First of all, 9.38% is not too shabby for an average return of all the momentum strategies tested.  As an individual investor, you would hardly decide to actually use the average strategy, instead you would usually use the best strategy, which, in this paper yielded about 15% per year.

Check out this graph:
Picture
Also, the paper shows persistent returns…meaning that momentum is alive and well, at least within the context of this paper.  The paper goes on to say that momentum strategies in commodities tend to buy contracts in backwardation and sell contracts in contango, which is no small trick, as these to states are regularly alternating.  

Finally, the paper looks at the correlation between commodity momentum and stock/bond momentum and shows it to be low, meaning that you can further reduce the volatility of your account by adding a commodity momentum component to your stocks and bond momentum strategy (which is the concept of global tactical asset allocation!!).

 


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